Wednesday, 24 December 2008

Markets aren't all bad

We need to follow the facts rather than the zeitgiest.

The Cambridge professor William Ralph Inge once quibed that ‘whoever marries the spirit of the age today will be widowed tomorrow.’ The Credit Crunch is producing a lot of future widows. It is suddenly fashionable to trash the market and laud the state. Those who now engage in this practise will look deeply unfashionable as soon as state intervention produces the next crisis and fashion changes accordingly.

Such thinking is the product of a false choice. To talk of just ‘market fundamentalism’ or ‘statism’ is glib and simplistic. If we try to understand the Credit Crunch in terms of this dichotomy, then we will not understand it. The credit crunch does not show that markets in general fail but that certain markets fail. Nor does it show that state intervention works because the crisis has been caused in part by bad interventions. We need to look at the particular mix of markets and interventions that produced the crisis and replace them with a mix that works better.

This post was inspired largely by this month’s edition of Liberator, which is full of statements like ‘the notion...that the efficient operation of markets can largely be taken for granted has been brutally assualted’ and ‘economic liberals have been left looking pretty silly by this autumn’s meltdown.’ In fact the truth is more prosaic. The present crisis is macroeconomic in nature and financial in origin. It does not tell us much about, for example, the merits of using Quasi-markets to deliver public services. And why should it; running schools is very different from trading in derivatives or deciding whether to approve a loan for a poor man in Detroit.

The fact that the Credit Crunch has financial roots is important because financial markets are unusual. So the lessons derived from them will not easily translate to other markets. Banks are both uniquely powerful and uniquely vulnerable because trading happens at an extraordinary speed and involves massive sums of money, so the potential for sudden and destructive crises is that much greater. Compare the bankruptcy of Woolworths and Northern Rock. The former decayed over years, the latter imploded in days. And because money underpins every other part of the economy a financial collapse creates economic carnage. Taken together, this makes the financial markets unusually dangerous and unusually important and as a result they will need an unusually large amount of regulation.

Gloating statists should also bear in the mind the role of government in producing this crisis. The cheap money that banks so eagerly lent to people unable to pay it back was available because of state interventions. When the American economy last stumbled back in 2001, policy makers responded with exceptionally low interest rates. The Chinese government encouraged Americans to borrow vast some of money from Chinese savers by pushing down the value of their currency. These interventions are at least as important as the deregulation of financial markets in creating the crunch.

The present crisis has been a boon for simple minds on the left, much as the fall of the Berlin wall was for their counterparts on the right. We need more thoughtful analysis than ‘more state, less market’ if we are going to understand what is happening to our economy and how we can stop it.